Machine-Readable Disclosure and ESEF 2020 – A New Era of Corporate Digital Reporting?

New regulation in the EU mandates public companies to file financial statements in digital format. Does the move to HTML and Big Data have the potential to push corporate reporting into the digital age?

The direction is clear: As of 1st January 2020, all annual financial reports published within the European Union must be set up in digital format, using Extensible Hypertext Markup Language (XHTML). Formally announced by the European Securities and Markets Authority (ESMA) back in 2017, the final draft of the Regulatory Technical Standard on the new European Single Electronic Format (ESEF) further specifies that where the report contains primary financial statements compliant with the International Financial Reporting Standards (IFRS), these shall be marked up in extensible business reporting language, so-called “inline XBRL.” In total, about 7,000 companies will be affected by the new EU regulation.

So, what does all this mean for corporate reporting?

By mandating listed companies to apply a single electronic format, their annual financial reports will become more structured, allowing analysts or consumers with special software to identify, read, extract and analyze certain information automatically. The idea behind the machine-readable format is to make corporate reporting more accessible, comparable and transparent for both regulators and other beneficiaries such as analysts, Big Data aggregators and investors, who could feed their evaluation models with comparable data automatically and without the risk of input data errors. And XHTML and iXBRL can be read by the human eye using a standard web browser, rendering annual financial reports in a separate PDF document redundant. To get an idea how this looks, take a look at a sample report with iXBRL tags. Clicking on the “Inline XBRL” tab on the upper right will enable you to visualize the information.

To facilitate the implementation of structured electronic reporting, the EU regulation foresees a two-year implementation phase. During this time, reports need to be in XHTML format, but only the primary financial statements such as balance sheet, profit and loss statement, cash flow, statement of changes in equity and related footnotes need to be labelled by XBRL. The so-called “tagging” of financial notes will remain voluntary. From 2020, however, the full consolidated financial statements drawn up in accordance with IFRS will have to be marked up using XBRL according to the ESMA’s taxonomy.

So far with the theory.

A climb with strong headwinds

Less than 20 months from its introduction, the new electronic reporting format has met with quite some skepticism, particularly among preparers.

“Companies object to the ESEF because they don’t see the business case or evidence of benefits,” explains Claes Norberg, Director of Accountancy for BusinessEurope, representing the interests of European enterprises from 34 national business federations. “A change to digital format would bring nothing but an increase in cost because of the XBRL tagging procedure and adaptations to potential changes in the taxonomy.” These costs would be passed on to stockholders and might impact competitiveness at international level. “Users of annual reports are different in their information needs and the way they want to consume data.”

There are many established third-party aggregators such as Bloomberg that already cater to their information requirements. According to Norberg, users such as financial analysts and investors are deeply accustomed to working with PDF and paper-based disclosure formats. “The debate is too focused on one single standard like XBRL, instead of leading a wider dialogue about more flexible options.”

Other critical voices question the integrity of XBRL tags, because under the current ESEF regulation they would not require formal assurance. The European Commission has, however, indicated on a number of occasions that they consider assurance inevitable. At this stage, the Netherlands is the only country in the world that requires companies to file XBRL-tagged annual reports with an electronically signed XBRL-formatted auditor’s statement. Unlike the Securities & Exchange Commission (SEC) in the U.S., the ESMA intends to make the machine-readable filings publicly available, which would disproportionately increase the exposure of EU companies compared to competitors from other jurisdictions.

“Companies hesitate to voluntarily tag their financial reports in iXBRL out of fear that increased comparability might compromise their competitive edge,” confirms Dr. Philipp Stampfuß, Managing Director at Amana Consulting, the leading provider of XBRL services in Germany. “They are almost entirely driven by compliance.”

Faced with this uncertain and complex situation, most preparers and consumers have taken on a wait-and-see attitude. Whilst the former keep XBRL-tagging to a strict minimum, the latter, in return, are deterred by the lack of comprehensive machine-readable information, which keeps them from implementing costly XBRL data-mining solutions and leaves them with third-party data providers and manual data aggregation instead.

“It’s a chicken-and-the-egg situation,” comments Paul Warren, Technical Director at XBRL.org. “As long as companies don’t make best use of XBRL, they won’t be able to materialize the associated benefits. But without proven benefits, they won’t commit to making best use of XBRL in the first place.” According to Warren, the obligation to use XHTML won’t necessarily stimulate online interactive reporting, as financial audiences traditionally prefer static formats such as PDF or paper.

Rather than adopting a comprehensive, integrated digital reporting approach, most companies are used to producing both their annual and sustainability reports in PDF format. For compliance reasons, consolidated financial statements are being filed as a separate XHTML document with the required XBRL tags. Even though changing these habits will take some time, Warren hopes that the new ESEF will be a catalyst to promote iXBRL and raise the value of corporate reporting in the long term.

Thomas Toomse-Smith, Project Director at the Financial Reporting Lab in the UK, recommends that accounting regulators around the world collaborate to support more standardized and interoperable reporting mechanisms such as XBRL more thoroughly. Beyond that, “investors should engage with regulators, auditors, assurance providers and companies so that XBRL data is of tangible value to the investor community.”

At this point it seems that machine-readable disclosure, in order to fully unfold its potential and provide value beyond regulatory compliance, would need to overcome its current limitation in scope, comparability, integrity and access of relevant data.

Scope: The iXBRL taxonomy would need to be comprehensive, allowing the tagging of all material information – not only financial, but also environmental, social and governance (ESG) data – to grant a full view on a company’s performance, risks and opportunities.

Comparability: The ESEF taxonomy would need to be aligned not only with IFRS but also with an equally recognized global reporting standard or framework for ESG-specific disclosure.

Integrity: iXBRL tags would need to be audited to assure full compliance with the underlying taxonomy.

Access: The machine-readable data would need to be publicly available for further processing.

Seizing HTML as an opportunity

Even though the new ESEF will add momentum to the trend of digital reporting formats, the breakthrough of iXBRL as a widely used standard to help identify, extract and analyze relevant data from corporate reports might still require some time. In the meanwhile, the majority of preparers are likely to continue pursuing a compliance-driven approach by producing separate iXBRL-tagged reports in addition to corporate annual and sustainability reports in PDF format.

Other early adopters, however, will take the ESEF mandate as an opportunity to change their corporate reporting from PDF to HTML formats, adopting an online, integrated, interactive and structured communications approach, turning corporate reports into a highly effective, multi-stakeholder communications tool. Rather than producing different reports in different formats, they cater their various audiences through one online integrated report in HTML format, leveraging the latest online technology features and disclosure standards, including iXBRL tagging. Menus, tabs and links guide the different stakeholders to sections with the information they need to take informed decisions.

In an “online first” approach, a report is set up in html right from the start, with the option to convert it to PDF or printed formats on the fly. It also allows the preparer to label all relevant data with XBRL tags right at the source, which eliminates the cost of manually reprocessing the final report, let alone the risk of human error. For companies struggling with tight disclosure and filing deadlines, this can be of critical importance. They not only reap the benefits of superior transparency and reporting efficiency, by choosing an integrated digital reporting approach they are also well positioned to accommodate more far-reaching regulatory requirements to promote machine-readable disclosure formats in the future.

While the breakthrough of machine-readable corporate reports might not be for tomorrow, the new European Single Electronic Format is, and early adopters will be well positioned to gain a practical lead.